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Three Stocks With Dream Price-to-Sales Ratios


Value investors use the P/E ratio to determine if a stock is cheap. But since P/E can be manipulated, we turn to the P/S ratio.

Many investors look toward various key ratios as a way to determine the value of a company. The most common one is the price-to-earnings, or P/E, ratio. Value investors use the P/E ratio to determine if a stock is cheap. The lower the ratio the cheaper the company.
However, the P/E ratio has its flaws. It is easier to manipulate earnings than other aspects of a company's performance. That's why I like to also use the price-to-sales, or P/S, ratio when I'm looking for top stocks.

What Is the P/S Ratio?

The P/S ratio uses the market capitalization of a company and divides it by the past 12 months' revenues. A low price-to-sales ratio is preferred as that means an investor is paying less for each sale.

It is more difficult for a company to tweak sales performance than it is to influence earnings, since it's pretty straightforward. Therefore, the P/S ratio can be a better indicator of hidden value than the P/E ratio.

What Ratio Do You Want to See?

Just like with the P/E ratio, the lower the P/S ratio is, the better.

When seeking out attractive fundamentals, you want to look for companies with P/S ratios under 1.0 as that usually indicates value. But it can also be helpful to compare a company's P/S ratio with those in its industry. Again, you want it to be lower than those in its industry as that indicates that it is paying less than its competitors for its sales.

Don't Only Use the P/S Ratio

The P/S ratio is not perfect. It shouldn't be the only fundamental you're screening for.

It doesn't take debt into account so a company can have a low P/S ratio but mounds of debt and therefore might not be a good investment. It also doesn't account for expenses, which can affect profit.

But if you combine the P/S ratio with other indicators, such as the P/E ratio, and then put the Zacks Rank on top of that, it can be a powerful combination for finding attractive stocks.
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No positions in stocks mentioned.
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